The US Supreme Court has agreed to review an insider trading case involving a man who used his brother-in-law's position as a banker at Citigroup to make more than $1.7 million. The Court's decision could redefine insider trading and could possibly make it more difficult for the SEC to prosecute insider traders who pass information among family and close friends.
Most of us have had access to non-public financial information just like the analyst in this court case. We should be really careful about sharing this information at all, but soon, the highest court in the land will tell us what constitutes insider trading. It seems like common sense, right? “If an insider gives you information as part of his job, you can trade on it, but if he gives you the information in breach of his duty to the company, then you can't trade on it,” writes Matt Levine at BloombergView. Pretty basic. Well, not always…
Imagine that you're Michael Kara for a minute. Imagine that your brother was an investment banker with Citigroup and that you were a chem major who took a really deep interest in your brother's work. You and your brother are tight, so after you prod him a little, he shares confidential information with you -– usually about upcoming client mergers and acquisitions. You decide to use this information for evil, and you start making trades based on the information that your banker brother has given you. You get good. Real good. So good, in fact, that you want to share the wealth with your brother-in-law and good buddy, Bassam Salman.
"Mirror my trades," you tell Salman and Salman does. The SEC will later claim in court that yours and Salman's trades were nearly identical from 2004 to 2007. Salman gets rich quick -– the account he used to hold his ill-gotten-gains grew from $396,000 to $2.1 million in just three years.
By 2009, the SEC catches you, your brother, and your brother-in-law. You and your brother plead guilty and testify against Salman in court. In 2013, a court convicts Salman of insider trading and sentences him to three years in prison. Seems straightforward, right?
So why is Salman's insider trading case heading to the Supreme Court?
To prosecute insider trading, the Government needs to prove a) that a trade happened and b) that the accused knew a trade happened. Salman claims a trade never happened. He claims that your brother never benefited from disclosing all that Citigroup client info to you. So, if the tipper never benefits, the tipper never traded. Back to Levine, who explains: “If the insider is getting a kickback for giving you the information, he's probably not doing it on behalf of the company: He's probably doing it for himself, and in breach of his duty to the company.”
Many tippers breach their fiduciary duty in exchange for bribes. Remember Scott London, the disgraced KPMG partner who traded inside information in exchange for “some cash, jewelry, and Springsteen tickets”?
Not all tippers trade for tangibles, though. Some tippers trade confidential information for intangibles like future earnings, or as a gift to a friend or family member. The SEC claims that your brother gave you all those insider tips as a gift because you two were so close. Your brother testified that he gave you the information to help himself: "The way that I thought I was helping myself was just by getting him off my back, and fulfilling whatever needs he had." That means your brother did receive a personal benefit in exchange for the info. That means you traded inside information. That means you're all guilty.
Well, Salman says that's bullshit.
From the Wall Street Journal:
Salman […] argued that evidence of a family relationship between the tipper and the tip recipient wasn't enough to demonstrate that the insider received a personal benefit.
Just because you and the Citigroup analyst are brothers doesn't mean your brother benefited from sharing those tips. Even if your brother the Citigroup analyst did give you those tips as a gift, how was Salman supposed to know that those inside tips were actually a trade?
Salman bases these arguments on a 2014 Court of Appeals case that overturned a conviction of two hedge fund managers. That case, U.S. v. Newman, found that “exchange of career advice wasn't enough to constitute a personal benefit" for the purposes of insider trading. As Levine explains, the Newman case decided that, "Giving someone inside information in exchange for a sack full of money: illegal. Giving someone inside information and getting a vague warm feeling in return: fine." Salman alleges your brother gave you inside information in exchange for that same “vague warm feeling.” In the Salman case, "Experts expect the [Supreme Court] to clarify what counts as a personal benefit and how the government could use a close relationship to allege insider trading."
SCOTUS could begin to hear arguments on the case as early as April. If the Court rules in Salman's favor, it could make it quite difficult for prosecutors “pursuing investigations into individuals who tip their friends or family but don't receive an explicit, consequential gift or benefit in exchange for the confidential information.”
Moral of the story? The same as with every insider trading case. Regardless of how you learn the inside information, don't trade on it. Regardless of whether or not you'll explicitly benefit, Don't share the information -– especially not with your greedy brother-in-law. You'll both get caught, lose your jobs and your illicit profits, and wind up in white collar prison making 38 cents an hour as groundskeepers like the embezzlers in that CNBC special “White Collar Convicts: Life on the Inside."